Fundamental analysis is a method intrinsic but necessary for successful investment in the financial market. If you are in this trade, chances are that you are already aware of fundamental analysis (FA). But if you are new or looking forward to investing in the stock markets for some extra profits during this economic recession, let us understand fundamental analysis and its importance in this trade.
What is a Fundamental Analysis?
Fundamental analysis is a method of appreciation of stock value by examining a host of economic and financial factors related to that particular stock. It is always recommended to study factors related to a company’s business health before investing in it to minimize loss or chances of it. There are macroeconomic factors such as the general economy of the country or trends in that industry that can affect a stock price as well. Fundamental analysis will help you determine these and make well-informed investment decisions.
How is Fundamental Analysis different from technical analysis?
Another term often used in financial markets that are close to fundamental analysis is technical analysis. The two methods are however not similar. While fundamental analysis reveals the correct value of a security and helps you identify stocks that yield good returns in the long run, technical analysis helps you find safe exit points when the stock prices fall.
Technical analysis is therefore an efficient tool for short-term investment in stocks but not otherwise. Since in the long term an investor looks forward to multiple times returns from stock, it becomes important to study and evaluate the fundamental strength of the company and the industry. The technical analysis reveals only downtrends and smaller setbacks that are not important in long-term investment.
Methods of Fundamental Analysis:
Quantitative Analysis:
This obviously involves the analysis of hard numbers by studying a company’s measurable characteristics. Analyzing a company’s financial statements will give an investor clarity of its worth. This includes going through their balance sheets, income statements, and cash flow statements.
Qualitative Analysis:
This involves the analysis of intangible factors that are equally important for determining the performance of a company. Matters like management competencies, credibility, brand name, and competitors should be looked into before any long-term investment. The four main qualitative aspects which should be analyzed are therefore a company’s management, its business model and strategies, the competitive advantage it has over other brands, and its internal frameworks like corporate governance.
How to do Fundamental Analysis?
Proper and in-depth analysis of a company takes learning and experience but as a beginner, you can follow the steps mentioned below which are the basics of fundamental analysis.
- USE FINANCIAL RATIOS, to begin with since complete financial analysis can be time-consuming. You can use any financial ratio tool like the Price to Earnings ratio, current ratio, dividend yield, etc to shortlist some companies with good prospects before getting into hard numbers in detail. There are several websites to help you screen the ratios of companies as well.
- RESEARCH ABOUT THE COMPANY and understand their qualitative aspects as well. Read thoroughly about their vision, policies, products, management team, and the like.
- READ THE FINANCIAL REPORTS. If you like the vision and prospects of a company, the next step is of course to jump into the analysis of hard numbers.
- CHECK FOR MAJOR DEBTS OR OTHER RED FLAGS such as low-profit margin, low liquidity, or pledging of shares. This would require a deeper look at a company’s history.
- CHECK OUT ITS COMPETITORS to ensure that you are choosing to invest in the best company in that particular industry. Find out why it is better than its peers.
Stay ahead in your stock trading game with the help of fundamental analysis.
